With the end of May, the adage of "sell in May and go away" is buzzing around the financial-news media.
In this week's episode of Industry Focus: Healthcare, Motley Fool analyst Kristine Harjes and regular contributor Todd Campbell look at the phrase's origins, how people look at the phrase today, and what decades of data have to say about how financially feasible it is to sell out of your stocks in the summer and buy back in during the fall. Find out some of the most important emotional, financial, and logistical problems with the "sell in May" investing strategy, how much merit the adage holds for the healthcare sector in particular, and more.
A full transcript follows the video.
This video was recorded on May 31, 2017.
Kristine Harjes: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's May 31, and I'm your Healthcare show host, Kristine Harjes. I have healthcare contributor Todd Campbell on the line, who is freshly back from a vacation in Ireland. How was your trip?
Todd Campbell: I'll tell you, listeners, if you haven't been to Ireland, go. The people there are so wonderfully friendly; they're so welcoming. It was just a great time. We went to Dublin, and then we went up to Belfast, and we went up to Londonderry or Derry, depending on whom you talk to. It was a great time, and the people were wonderful. It was really interesting to see Northern Ireland, because, in the past, there's been a lot of troubles there. But that's all behind them now. Great people, and some wonderful things to see and do.
Harjes: That sounds awesome, I'm so glad you had a good time.
Campbell: Yeah. And I wasn't the only one who was away. Kristine and I both timed our vacations perfectly. Kristine, you were away too, weren't you?
Harjes: I didn't go quite as far, but this past weekend, I was in Nashville, and the weekend before that, I was in Toronto.
Campbell: That's right. You were going to listen to some great music, I believe.
Harjes: Absolutely. Nashville has an incredible music scene. It's probably fairly well known and shouldn't have been surprising to me, but I was still blown away by, every single bar you go into or restaurant or wherever you are, no matter what time of day it is, as long as it's not too early in the morning, you can go in and find really good live musicians. There was this one guy we were listening to for a couple hours one afternoon. His name is Tony Memmel, and he sounds a lot like Counting Crows, which we all like, so we ended up buying his CD, and on the 10-hour drive home, we listened to his CD on repeat for probably four of those hours. So, really good music.
Campbell: I guess I'm going to go out, I'm sure some of our other listeners are going to go out, and check this musician out.
Harjes: I will recommend the game that we played with his CD, which is that we were alternating between that and Counting Crows randomly, and the game we would play is, which one is it? And we got pretty good at it, so we recognize ourselves some Tony now. But you must have had some good music, too, yeah?
Campbell: Yeah, a little bit of a different style of music. There's nothing better than sitting in a good old-fashioned Irish pub and listening to them sing Irish music while you're drinking a pint. It was a wonderful time. It was a wonderful experience.
Harjes: And are you happy to be back? Hopefully?
Campbell: Yeah, absolutely. We're back and we get to talk about the market again. We love this stuff, so it's always fun. Coming back from vacation and being able to dive right back in, especially with our topic today.
Harjes: Yeah. It's always a little bit bittersweet. You don't want vacation to end, but we're fortunate to really enjoy what we do for work. So it's nice to come back. As you alluded to, we have a fun topic for today. It's the last day of May, as you guys all know because I said the date in the beginning of this podcast. So we wanted to talk about the popular investing adage of "sell in May and go away," which is a historical thing. It's been around for a long time. Its history actually comes all the way from London. The full phrase is, "Sell in May and go away, come back on," I think I'm going to pronounce this wrong, "St. Leger's Day." In my research of this, I'm pretty sure you're supposed to pronounce it as one word, but my apologies if that is still not correct. So this is a horse race known as St. Leger, and it's run in mid-September. So the adage has this history of traders in the summer, your aristocrats and merchants from a long time ago, they all vacationed in the summer. They were getting out of the city and trying to beat the heat, so they would go away and they wouldn't come back until fall. So the theory here is, if you sell out of all your stocks in May, and you don't rebuy them until October or Nov. 1, which is a very popular buy-back-in date for people who believe in this theory, that you'll be better off.
Campbell: Right. And back in the day, Kristine, it wasn't like you could take a six-and-a-half-hour flight to Ireland. If you were going away, you were going away for a while. And you didn't have the technology we have today to be able to keep track of your portfolio and the stocks and do research. So there were significant delays in getting access to information. That's obviously not what you want if you're an active investor or trader. Here at The Motley Fool, we embrace a long-term philosophy. We're not the ones to dive in and out of a stock just because there happens to be an adage out there. But we also don't bury our heads in the sand to these things. No matter where you are right now, if you're paying attention to the marketplace, you're hearing this adage pop up, so you're probably asking yourself, is this something that I should be following or paying attention to, or not? There is data out there, Kristine, that backs up, even today, the idea that performance tends to swoon during the upcoming summer months.
Harjes: Yeah, it's really interesting if you look at the numbers behind this, because they do give some credibility to this theory. Again, I do want to reiterate that we are long-term investors, so we're not going to dip in and out of stocks. But as you mentioned, Todd, and I think you did a great job of explaining this, it's still kind of important to check out these theories and look at their data and say, is this a complete data set? What might be missing from it? How can I apply this to my more long-term ideology? The people who ran the data for the first time, at least in the most well-known sense, is from the Stock Trader's Almanac, which used to be a book that was created in 1967. It's now a whole website. They do a lot of database trading strategies. They ran the numbers from 1950 all the way through 2014 and compared the two periods to see whether or not you might actually be better off not investing at all during the summer months.
Campbell: Yeah. And they found, if you break down average return by month, there are four months since 1950 that have negative returns, on average. And three of them fall within this "sell in May" period. You have June, August, and September. Those are three negative months. So you say, OK, they're negative, and on average, you could lose money during those months. What would that mean to a portfolio? And if you look back and say, what would happen if you took $10,000 and invested it from May through October, or October through April? Would you make more or less money in either of those two periods? And what the Stock Trader's Almanac found, they update this data every year, but what I have is from the 2015 edition. At that point in time, if you look over that 64-year period that they looked at, putting that $10,000 to work during the "sell in May" period, you actually would have lost money, around $678, if you had been invested just during those months, May through October, since 1950. That was in the Dow Jones Industrials. Conversely, if you had had that $10,000 invested in the period of October through April, then you would have ended up with $816,000. So when you look at the difference there, yeah, that's significant enough where it's definitely going to catch your eye. And I think one of the things it reminds investors of is, if you have a big drop-off of a high base, it takes a much larger gain to make up for that drop.
Harjes: Right, a 50% drop will require a 100% return to break even.
Campbell: Right. So that's what makes it really hard when you're looking at the compounding. Now, no one knows which months are going to be good or bad. But it is interesting that so many of the months, over time, have been negative, fall within these summer months. And you did a great job summing up, historically, why the theory behind that, the vacation schedule and all of that. I think it's important though to also say, you're only looking at the Dow Jones Industrials with those numbers, and that's 30 stocks. Of course, the market is much bigger than that. If you broaden that out and say, what would those dollars have looked like for the S&P 500, you would have made money. It wouldn't have been a lot, but you would have made money, $6,800 or something like that. So you can't necessarily say, "I'm not going to be invested at all through the summer months," because there's an opportunity for stocks to go up, and you just don't know what any one year or not is going to materialize.
Harjes: Right, and there are a lot of details that often get lost here when you consider what actually goes into selling all of your stocks and then buying them back again. For example, one thing that isn't included in these calculations are transaction costs. If you are selling a basket of 30 stocks and buying them back, say you have a $7 transaction fee, that's going to cost you $420 a year just to buy in and out. Then, what happens if all of a sudden it comes time to buy and you're in the middle of a broader market drop, and now you're terrified of actually buying back in? Can you really commit to this?
Campbell: Yeah, you won't. Kristine, that has to be the hardest thing for an investor. If you sold out and you see the market tumbling, what's the likelihood that you're going to say to yourself, "I'm going to rise up to the sticking point and put this money back to work"?
Harjes: Especially if you're someone who tries to time the market, you're probably the exact same type of person who's not going to be able to buy back in.
Campbell: Yeah. There's also tax implications.
Harjes: Absolutely, yeah. If you sell in May every single year, you're going to be paying short-term capital gains taxes, which can be pretty significant compared to your long term.
Campbell: Right. As it stands today, that's taxed at your ordinary tax rate, where the long-term tax rate for capital gains is only 15%. If you're at a higher tax bracket, that could cause some problems for you during tax time.
Harjes: Right. Of course, hindsight is 20/20. It's impossible to predict, going forward, whether this is going to continue to hold up. You never really know on a given month. I have read about an alternative strategy to this, which is kind of interesting. It involved selling out of more volatile stocks during that summer doldrum period and buying the more stable ones during that time, which is an interesting thought and makes me think about how you can look at different sub-sectors of industries and compare them to one another to try to find the best opportunities. And when you think about whether or not parts of different sectors, or even sectors as a whole, are affected by cyclical trends, one of the things that stands out to me is drugmakers. If you're making medicine, that's in demand, regardless of what's going on in the macro world. That was a very long-winded way of saying that what I want to explore next is, does this adage hold merit in healthcare?
Campbell: Right. This is a healthcare investing show, so the people who are listening are very interested in what happens to medical-device companies and pharmaceutical companies and biotech companies. So, what we did is say, over the last decade, what's happened to the major market ETFs, exchange-traded funds, that track different parts of healthcare? Have they lost ground during the "sell in May" period, or have they gained ground? And it was kind of a coin flip. If you look at the pharmaceuticals ETF, the XPH, it was up five out of the last 10 years, had an average return of a little bit less than 1%. The biotech ETF, the XBI, that was similarly up five out of 10, with a slightly better average return of 2.35%. So there are baskets that, again, you don't know, it's a coin flip. But the average in the median returns, shouldn't necessarily scare you away. The XLV, again, up 3.99% median return over the last 10 years in this period. Are you willing to throw the baby out with the bathwater and risk missing what could be a solid period of returns? I don't think you should. But I think it's important to recognize that this is going to be a period where maybe the returns won't be as easy to come by as they would be otherwise, through that November-through-April period. And that's maybe a good reminder for investors to go back and look at the stocks in their portfolio and say, are the catalysts, the reason why I bought this stock, still intact? Or has something changed? Are the reasons for owning it still applicable? If they don't, is there another stock that I might want to consider a different strategy for, and looking to pick up if it gets weak over the summer months?
Harjes: Absolutely. Of course, we always recommend this bottom-up analysis where you're actually looking at the companies themselves. On this show, you hear us talk all the time about drug pipelines and strategic initiatives and what executives are up to. That's because we care a lot more about that than we care about share-price movements or beta or any of the technical things you'll see in other outlets. And that's how The Motley Fool does it. It's worked for us for a long time. Hopefully, if you're listening to this show, it's because you agree that it's a great way to invest. But as we keep saying throughout the show, it can be interesting to consider how some other ideologies might look at investing, and seeing what the actual results are. One thing that I think can come out of this in a really helpful way is looking at the different ETFs that track the different sub-sectors of healthcare, and trying to see how those are trading relative to their historical norms. You hear a lot of people saying biotech is really expensive, and I do think that sort of analysis is also really informative. Is this a sector overall, as compared to the S&P, or just the sub-sectors within it compared to each other, or compared to their historical norms, what does that landscape look like?
Campbell: Yeah. The argument could be that the market itself is overheated. We've had this massive run-up since the Great Recession ended. You could make an argument that the market P/E is a little bit extended. But at the same time, as healthcare investors, our valuations really aren't that out of control. And a lot of that is due to all the things we've talked about in the show previously, the political push-back on prices and healthcare reform and all of that other stuff, that have sent some healthcare stocks, including biotech, lower, not higher, as the market has been hitting its 52-week highs over and over again. As a result, the P/E for healthcare itself is cheaper than the market, and so is the price to sales. So an argument could be made that healthcare isn't as overheated as some other baskets. Then, within healthcare, biotech especially is well off its historical P/E.
Harjes: Which really surprised me.
Campbell: A lot of these stocks really got hit hard in 2015. They're starting to build back up from there over the course of the last six to 12 months. But they remain off of those peak valuations that we'd seen. Maybe the exception there is some of the medical-device stocks. Those stocks have rallied up a lot more, relative to where they had been previously on hopes that the dismantling of Obamacare would remove the medical-device tax. So, maybe that's something to keep in mind as well. But to go back to what you said previously, I would much rather just focus on owning great companies at fair prices. You go back to the Buffett litmus test. You think Warren Buffett is out there worrying about "sell in May"?
Campbell: I don't think so. I think he's worried about finding great companies that he can buy at fair prices.
Harjes: Yeah, I would agree with that. If I have companies that I really believe in, why would I want to not own them for half of the year? If I truly believe in them, I want to own them all year. I want to own them for years and years and years.
Campbell: Right. You also mentioned earlier in the show that you could consider getting rid of some of your volatility, some of your more volatile or higher-risk parts of your portfolio. And, again, if something has changed in the catalyst, this might be the right time to do that, to rethink the allocation, maybe take a little profit off the table, maybe write a couple puts, check in with our options ideas on The Motley Fool for some options writing strategies that might allow you to buy things at cheaper prices. There's ways to take advantage of the market, if it does fall, if you have a little bit of dry powder.
Harjes: Absolutely. I think, when it all comes down to it, the biggest takeaway that I have from this episode is, don't listen to advice just because it rhymes. That's not a good reason. It sounds good, and you should understand it, because people do talk about it, but that's not the end-all, be-all.
So there you have it. Todd, we may have just lost some listeners for the next six months, but we sure hope that we didn't, and you will all be back next week for our next episode of Industry Focus: Healthcare.
As always, people on the program may have interests in the stocks that they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. This show is produced by Austin Morgan. For Todd Campbell, I'm Kristine Harjes. Thanks for listening, and Fool on!